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Dollar posts best month since 2016 as Fed stays less dovish than peers

The U.S. dollar had its best month in almost three years as the Federal Reserve remained more hawkish than its peers and rival currencies stumbled amid the growing risk of a no-deal Brexit and weakening European growth.

The Dollar Index, which measures the performance of the U.S. currency against some of its biggest trading partners, surged 2.5% in July, the biggest gain since November 2016. It closed at 98.516 on July 31, the highest level since May 2017. It advanced against all of its G-10 peers, led by a 3.8% rise versus the British pound. It added 2.2% against the euro.

While the Federal Reserve cut its benchmark interest rate on July 31 for the first time in more than a decade, Chair Jerome Powell signaled a reticence to lower rates aggressively in the remainder of the year. Coupled with hints of more dovish monetary policy from the European Central Bank, which already has some policy instruments below zero, interest-rate differentials continue to favor dollar-denominated assets.

The pound declined the most against the dollar since October 2016, four months after the British electorate chose in a referendum to leave the European Union. New Prime Minister Boris Johnson's insistence that the U.K. will exit the EU with or without a deal on October 31 while showing little enthusiasm to negotiate on terms acceptable to the bloc has heightened concerns of a disorderly Brexit.

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The dollar's July gains should also be seen in the context of a weak June where it experienced its first decline in five months and, at 1.7%, the biggest since January 2018.

The dollar has been so resilient throughout July because of the fact that central banks elsewhere in the world have been even more dovish than the Fed, according to Fawad Razaqzada, a technical analyst for Forex.com, who noted the slow pace of growth in the eurozone economy and the impact of Brexit on the pound. "As a result, the Dollar Index has remained underpinned, even despite the Fed's dovish U-turn on monetary policy," he said in an interview.

Data yesterday showed that core inflation in the eurozone slowed more than expected in July to 0.9%, while economic growth in the second quarter dropped to 0.2% from 0.4%, bolstering the case for lower rates and a resumption of bond buying from the ECB. The Bank of England said today that leaving the EU without a trade agreement will see further declines in the pound, faster inflation and slower growth, while noting that it's less confident than usual in its economic forecasts because of the uncertainty around Brexit.

U.K. manufacturing continued to contract in July, according to a report published Aug. 1. At 48.0, PMI was unchanged from June's 6.5-year low and below the 50 that signals expansion for a third month in a row.

Though the U.S. economy is slowing, it is still outperforming many of its peers, including a weakening manufacturing sector in China and the eurozone, said Ryan Sweet, director of real-time analytics at Moody's Analytics.

"Uncertainty is the word for 2019," Sweet said. "And typically during periods of elevated uncertainty the dollar continues to be a safe haven."